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A strong-arm policy is needed to hold the pound down on the rebound

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    A strong-arm policy is needed to hold the pound down on the rebound

    http://www.telegraph.co.uk/finance/c...e-rebound.html

    A strong-arm policy is needed to hold the pound down on the rebound
    A low pound is essential for the UK's economic recovery and should be a political priority, writes Roger Bootle

    It is now almost four months since Jim Rogers' infamous comments about the pound. "I would urge you to sell any sterling you might have. It's finished. I hate to say it, but I would not put any money in the UK."

    In the wake of his remarks, the pound fell to around $1.38, €1.06 and 73.9 on a trade-weighted index. Since then, the pound has gradually crept up. The trade-weighted index has risen by some 5pc, with the rate against the dollar above $1.50, and against the euro above €1.10. My worry is that the pound may move up in a big way. I say "worry" because the weak pound is critical to the hopes for economic recovery.

    Why should the pound rise? Because it fell a very long way, indeed to a level on a trade-weighted basis below that which it reached in the years immediately after the exit from the ERM. The pound seems particularly vulnerable to a rise against the euro, given the ghastly economic situation in the eurozone and growing pessimism about the policy response.

    You may think the idea of the pound turning out too strong for our own good is fanciful. If so, you may not be familiar with our history. In 1976 the UK experienced so severe a financial crisis that it went to the IMF for help, and the pound plunged. But not much more than a year later it rebounded so strongly that the Bank of England intervened massively on the exchanges, selling sterling in huge quantities, to try to hold it down.

    Our chances of getting a favourable response to the low pound depend not only upon the pound being low now, but on producers believing that it will stay low in the future. If they believe this then it will be worth the effort to build up markets, sales forces and supply chains, and to invest in plant and machinery. If, by contrast, they believe that the weak pound will be a passing phenomenon then they may well think that such investment is not worth the effort and expense.

    And the evidence of the past will not encourage them. The pound has been on a roller-coaster for more than 35 years. What's more, government policy on the pound has been on a roller-coaster as well, veering from putting control of the exchange rate as the central objective of financial policy to complete neglect – with various stages in between.

    Between the end of the Second World War and 1972, the UK had a fixed exchange rate. We then switched to a floating exchange rate. Following a period of turmoil in the mid 1970s, in 1979-80 Margaret Thatcher welcomed a strong pound as part of her anti-inflationary policy but the authorities didn't target the exchange rate.

    But in the early 1980s, the pound plunged and reached near parity with the dollar. Now the government became more concerned about the pound, but still didn't target it.

    In the late 1980s, however, under Chancellor Nigel Lawson, the UK surreptitiously shadowed the Deutschemark, so we were on a de facto exchange rate target. In 1990 we joined the ERM and for the next two years, the pound was again officially the centre of economic policy.

    After the exit from the ERM on Golden Wednesday in September 1992, as our chart shows, the pound plunged. It was soon realised that this would greatly assist the process of economic recovery. Which it did – while it lasted. But the authorities still had no policy for the pound. Instead, they were targeting the inflation rate. Before Labour was elected in 1997, the pound started to rise strongly and it carried on rising afterwards. There then followed a long period of rough exchange rate stability – at the wrong level.

    Then the pound started to fall sharply in late 2007. Now we again find ourselves looking to the weak exchange rate for a way out of our current mess.

    The authorities are currently considering the whole shape of economic policy, and the shadow Treasury team in the Conservative Party is doing the same. Everything is in the melting pot – as it should be. At the moment, the prime concern is how to accommodate asset prices in the policy regime and how to target financial stability as well as inflation. As part of this process of assessment they should pay close attention to the pound. Whenever this country experiences one of its periodic bouts of euphoria and subsequent crisis, the pound is always somewhere at the bottom of it.

    What could be done? Well, one partial way out of this problem would be to join the euro at somewhere near the current ultra-competitive rate. Regular readers will know that I think that there are other drawbacks to that!

    But there are other things that could be done. Concern about the pound should influence the shape of policy tightening when the recovery comes. The aim should be to tighten fiscal policy first and to raise interest rates last, in order to try to help the pound to stay down.

    Moreover, there is another instrument potentially available to help attain the objective – namely sales of sterling on the exchanges. If the Bank is still pursuing quantitative easing this may amount to a way of continuing to pursue this policy in a slightly different way. It would have the same effect on liquidity and the money supply but it would involve the Bank acquiring different assets, in this case foreign securities.

    Another instrument to be deployed is talk. Now I wouldn't want to overdo this but neither should it be completely disregarded. After all, in the current inflation targeting regime the authorities place great store by the importance of talk – in trying to persuade the public that inflation will indeed stay low. This can have a role in the exchange markets also, by persuading operators that there could be a policy response if the exchange rate moves too far. By contrast, the posture of telling the markets that there is no official attitude to the exchange rate and that it will be left to its own devices gives the authorities minimum leverage.

    I am not arguing for a return to exchange rate targeting, but I am arguing for an exchange rate policy – and for that policy to be considered as part of the overall reconfiguring of macroeconomic policy. Otherwise, I have a ghastly feeling that just as we get on our feet again the pound will take off and wipe out the competitive advantage which is so central to our hopes for recovery.

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